Managed Futures Wins Round One Versus Bill Gross

It wasn’t that long ago that Bill Gross stood squarely against managed futures, shouting the demise of U.S. treasuries as a viable investment from the rooftops. We disagreed with him then, believing the trend in bonds to be decidedly up.

This is where we get to say “told you so.”

From the Financial Times:

Bill Gross, manager of the world’s largest bond fund for Pimco, has admitted that it was a mistake to bet so heavily against the price of US government debt.

Mr Gross emptied his $244bn Total Return Fund of US government-related securities earlier this year in a high-profile call that has backfired as the bond market has rallied. As of Monday, Pimco’s flagship fund ranked 501th out of 589 bond funds in its category.

“Do I wish I had more Treasuries? Yeah, that’s pretty obvious,” Mr Gross told the Financial Times last week, adding: “I get that it was my/our mistake in thinking that the US economy can chug along at 2 per cent real growth rates. It doesn’t look like it can.”

Between treasuries continuing to impress the markets (despite a small slide today) and our recent research, which suggests that bonds play a crucial role in managed futures crisis performance, we’re thinking that Gross’ admission of crying into his beer after a bad call is probably coming to fruition. In round one of Bill Gross v. Managed Futures, the win, decidedly, goes go managed futures. Whether or not this trend persists remains to be seen, but for right now, we’re liking the odds on the managed futures side of things… and looking forward to the day that Bill Gross comes ’round to our side.

Trading Futures: The Game

Checked out the CME’s Trading Simulation Game this morning, and they win the award for creating a game that is NOTHING like the real deal. They give you a chart, a buy button, and a sell button – and then put some fake news along the right side of it. Here’s how I did in my first attempt – 100% winners for a “play” profit of $4,586, which the software says makes me a “spectacular speculator,” where “your expert trading left you with a ridiculously huge profit.” Yeah, right.

Here’s the screenshot of my buys and sells, which were, admittedly, perfectly timed at the swing highs and lows.  If only the real news had that little green or red arrow next to it when it came out saying which way it would affect the markets, AND the markets actually followed that and moved that way for a few weeks without any reversals until the next news (which again has the nice green or red arrow).

The high score is set at $4,586 play dollars (you can only do a max of 10 contracts)– who can beat it on this kindergarten level simulator?

UCITS: Expensive, Complex, Worth it?

Europe and the U.S. may be viewed as Western titans in the public sphere, but there are certainly unique differences between the two juggernauts. Whether it’s food, culture, or politics, each region has its own flavor. One of those differences as it relates to investing which is gaining more and more notoriety is the rapid increase in the popularity of so called UCITS funds.

While the European regulatory framework is well outside of our expertise, we have been getting somewhat frequent questions regarding UCITS (What are they? What do I need to know?), and decided to dig a little deeper into UCITS funds.

UCITS stands for ” Undertakings for Collective Investments in Transferable Securities.” It was developed as a European Directive in 1985 as part of an EU effort to establish a single market for financial services in Europe via a unified regulatory framework for mutual funds. The goal was to eliminate the need for managers to go through the red tape of each country, and instead create a single set of rules which managers could follow to promote their products in all EU member states. The benefit for investors was consistent protection no matter what country the product was originated in.

Essentially, the idea is the same as a mutual fund here in the US, where the company putting the fund together can forego having to comply with the rules in all 50 states by complying with an overarching Federal set of rules (a registered investment company) instead.

Well, the UCITS folks are now on their fourth version of the directive and it finally seems to be getting legs and gaining a market share in Europe. We went in search of more answers surrounding how this works from a managed futures perspective, but unfortunately found more questions than explanations.

UCITS is essentially a very complex briar patch of regulations that is next to impossible to interpret without some guidance. Seek clarification on terms used, and you’ll find six different interpretations of the rule. The lack of clarity makes it seem like more of a hassle than it’s worth.

Here were our take aways:

  • There’s no established system for paying taxes on the investments if you live outside of Europe. For our clients in other parts of the world, that’s close to a non-starter.
  • They’re expensive to launch, costing hundreds of thousands in initial fees. Add to that the extra you’re paying to have legal counsel keep you compliant with the aforementioned briar patch, and it ain’t cheap.
  • Part of the regulations limit global exposure and mandate certain margin-to-equity ratio levels. The best translation of this that we’ve found? Commodity exposure is limited, and positions can be thrown for a loop if an investor withdraws a large amount of funds if the manager wants to stay compliant with those margin-to-equity requirements.
  • We’re still not clear on what kind of commodities can be invested in. Some places say it’s fair game. Others say it has to be indices reflecting the commodities. We know there’s a so-called “trash ratio” that allows you to invest in “non-eligible” assets, but that it can only be 10% of the portfolio. Depending on how this is implemented, we’re not sure how some CTAs would function under the UCITS seal.
  • There’s some conversation on UCITS funds not tracking the performance of the programs they were derived from… at all. This comes down to tracking error created by a minimum investment/fund size mismatch. Imagine a program which takes one contract of Crude Oil for every $500,000 in equity. Say they have $5million and 10 contracts of Crude Oil held in the fund. Now what happens when someone adds $200K to the fund?  The program can’t add 2/5 of a contract easily, so there becomes a mismatch between what is supposed to happen in the program and what happens in the fund. One high profile firm we spoke with which has chosen not to go down the UCITS path cited just such a funding mismatch as their reason for passing on a UCITS fund – saying the liquidity requirements can create a problem where the fund is either over or under represented in certain contracts.

We were able to get one European managed futures participant on the record, speaking with Alistair Evans of Qbasis Invest. Despite their European roots, Qbasis chose instead to launch an ETF that tracks their performance last year, and most recently, an index that does the same. He believes that this may become a bigger trend in Europe, as funds try to secure investor confidence without paying the high premium associated with launching and maintaining a UCITS fund.

Bottom line: While UCITS funds may appear to be a good thing for the investor, the complexity and issues inherent in it can cause underperformance issues that need to be considered. Is the ease of access worth the potential under performance is a choice for each investor.

From the manager standpoint, the high cost of setting up and maintaining a UCITS fund appear prohibitive for anyone but the largest of large managers (several hundreds of millions under management). Managers must also consider the level of complexity in following the rules in terms of liquidity and opportunity cost of not being able to match their model to the funds funding completely.

Why Managed Futures Love Bonds

Our weekly newsletter is out, and this time around, we’re letting you in on a secret ingredient in managed futures success- bonds. When most people think of the bond market, they think of nerdy fixed income analysts and boring, low rates of return. After all, there isn’t a whole lot of excitement in an investment whose sole proposition is – you loan us this money, we pay you back the money plus annual interest of xx%. There isn’t a new product launch, burn rate, USDA crop report, or currency market intervention to contend with – it is just principal, coupon rate, and duration (oh, and credit worthiness, but most ignore that knowing there is a government backstop likely available). All in all – bonds are boring.

But when managed futures see bonds in the portfolio, they see anything but boring. There just happen to be futures markets on bonds, and managed futures programs are traditionally big players in these bond futures, trading everything from 30 year US Treasury Bond futures to New Zealand Bank Bills.

But why, exactly, has this love affair blossomed? It may have something to do with the results of several tests we ran while investigating the matter. Find out just how much bonds contribute to managed futures crisis performance by reading on.

Click here to see the full piece:

Stock Diversification Doesn’t Work – This is News?

Just a couple of weeks ago, we delved into the biggest selling point for managed futures: non-correlation to traditional asset classes. That means that regardless of whether stocks are up or down, managed futures has the potential to make or lose money.

Turns out, all those advisors who have trumpeted diversification within stocks and not outside of stocks are probably wishing they’d bought into managed futures when they had the chance.  As Josh Brown over at The Reformed Broker explained:

The WSJ is out with a story on this summer’s return to hyper-correlation of stocks.  Credit Suisse calls it currently as an 80% correlation for S&P 500 names, higher than the 73% we saw during the panicky peak in 2008.

It’s kind of hard to diversify in a climate such as this, which is why managed futures can be such an excellent addition to a portfolio. Brown points out that, under these circumstances, the jump in correlation is often short-lived, but it is the warning that booms from the Wall Street Journal about the future that becomes an excellent call to diversify now… instead of later.

The big fear for investors is that correlation will remain permanently elevated. While August’s turbulence can be blamed on specific macro issues, correlation levels have trended higher in the last few years. That suggests structural changes may have played a role.

One potential reason is the popularity of exchange-traded funds. ETFs account for more than 30% of volume in U.S. stock markets, compared with just 2% in 2000, Credit Suisse says. It’s reasonable to expect ETF trading to drive correlation higher because many of the vehicles are tied to stock indexes.

If they’re right, and correlation is becoming a structural reality, it’s time to stop deluding yourself into thinking that stock diversification is enough to protect your investments, and start looking for true diversifiers, like managed futures.

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